Leonid Ikan
(Note: This is a Canadian company reporting in Canadian dollars unless otherwise noted.)
InPlay Oil (OTCQX:IPOOF)(TSX:IPO:CA) was founded, like many of the smaller companies, with the support of companies that know the industry. InPlay was originally formed by the merge in reverser with the publicly traded Anderson Energy. Management originally decided to go public through the reverse merger in 2016, when the business cycle looked like a typically good time to enter.
But despite the success of many companies with the strategy of going public (and selling the company later in the cycle) during a downturn, 2016 proved far from the ideal time. The 2018 commodity price rally proved incredibly short-lived. So many backers have been unable (or unwilling) to sell their businesses. Then the 2020 financial year was unusually challenging. The meant that many previously successful companies had to sell their businesses either at distressed prices or worse.
InPlay management has navigated this rather challenging series of events to emerge as a relatively strong company as of this writing. There doesn’t seem to be that rush to acquire many businesses to grow in size that you see in other survivors. Instead, the line of business seems good enough to allow the company to repay debt. A relatively small acquisition was made in the past. That seems to fit with the notion that acquisitions will be relatively rare and the focus is on organic growth. Profitable trading will also be a decisive factor in the future. That sets this company apart from others like Tamarack Valley (OTCPK:TNEYF), where management quickly sought to minimize size in order to be a more effective competitor.
InPlay Oil Third Quarter 2022 Summary Operating Results (InPlay Oil January 2023, Company Presentation)
Management has used the acquisition to increase production to nearly 10,000 BOED where some important cost savings are likely to materialize. For a small company, the results were surprisingly good. This way gives credibility to all experience management advertisers before starting this business.
Management emphasizes the growth of the light oil business in the forecast for 2023. This company is managed conservatively. So investors should expect steady growth with occasional acquisitions (probably small and “dim”).
A company like this will try to show relatively rapid growth that is very profitable. The goal of the backers of such a company is to eventually sell the company for a good price. But the only way to do that is by demonstrating above-average growth with above-average profitability over time.
As a result, investors looking for dividend income will likely need to look elsewhere. Dividend yield won’t be nearly as important as maximizing the company’s long-term value for an eventual sale.
This company, like many of its peers, has paid back a lot of debt, so another period of weak prices will keep the debt ratio low during this period. Canadian lenders generally think differently about the industry than lenders in the United States. As such, the metrics that emerge during an industry downturn typically don’t trigger “alerts” like they do in the United States. However, the long-term goal of acceptable ratios was impacted by the cyclical downturn in 2015 and again in 2020, just like in the United States. As a result, Canadian companies will have acceptable levels of debt, leading to better ratios at far lower commodity prices than is currently the case.
Growth history of InPlay Oil as measured by management (InPlay Oil Company Presentation January 2023)
All focus on profitability. The difference here is that when debt ratios got out of hand in fiscal 2020, management fixed the situation with a small acquisition using a few shares combined with a program to pay down a significant amount of debt. The focus on profitability is thus in the top range with few comparable situations. Most of the companies I follow have had to acquire stocks and debt (to get enough acreage and production) to immediately improve the debt ratio.
Shareholder dilution was greater, although the path to acceptable leverage ratios was much needed. Most of the acquisitions made (by different managements) have been accretive per share. There seems to be a focus on organic growth here as this is seen as maximizing profits should the company be sold.
It should be noted that growth will continue to be somewhat clumpy as shown above. Commodity prices are too volatile for a straight line up. Leverage ratios will fluctuate similarly going forward.
InPlay Oil three-year forecast (InPlay Oil Company Presentation January 2023)
The advantage is that space is usually available and cheap for a company looking to grow organically. Management experience in the earlier establishment (and in some cases) sale of companies makes this strategy attractive for a small company like this. The companies that were originally behind the founding of the company often have management resources that are not available to competitors of a similar size.
As shown above, management forecasts a drop in oil prices. Still, they intend to ramp up production fast enough to overcome the decline. But as mentioned, given the volatility in commodity prices, actual execution of the strategy is much more likely to result in lumpy growth.
The future
Management has enough experience that the future strategy could change at the right price. This company will probably eventually merge with another small company. But Alberta’s businesses seem very profitable for companies of all sizes. So until such a merger opportunity arises, this management is pursuing a very viable strategy of organic growth with occasional add-on acquisitions.
Management is also paying down long-term debt while also declaring a small dividend. It also speaks to the profitability of the operation, as much of the industry isn’t growing at all while the balance sheet is being repaired.
The stock price, like many others in the industry, has pulled back from the high pint earlier in the fiscal year. But enterprise value versus projected cash flow is in the very low single digits in most scenarios. Currently, enterprise value is in the $250 million range, while cash flow is expected to exceed $100 million (in US dollars) over the next 12 months.
A basket of companies like InPlay should outperform the market and the industry over the next few years. The industry is likely to return to historical multiples closer to 6 (rather than currently around 2.5) over time. So the current recovery still has some “room to run”.
Editor’s note: This article covers one or more securities that are not traded on a major US exchange. Please be aware of the risks associated with these stocks.
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